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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Sense of Sensex

Posted by Muthu on March 28, 2013

Sensex as on last trading day of March 2012: 17404

Sensex as on last trading day of March 2013: 18835 

Sensex has gained 8.22% in the last one year. 

Since this is the current financial year end, I was going through the above data. While doing so, many headlines came to my mind – Sensex at 4 month low, Markets gain yesterday was highest in the last 18 months, Sensex tanks due to euro crisis, Markets down by concerns over sovereign rating, Market tumbles on the fiscal cliff, Black Monday, Markets buoyant after FM’s speech in Singapore, Markets at 6 month high, Diesel price rise fuels market……. 

There are around 250 trading days every year and there is a headline for almost every one of them. Our mood goes up and down according to the headlines and market levels. Instead if we look at once in a year, at the end of each financial year, ignoring all the headlines in between, time and mental energy would not be wasted.    

We’ve been going through pain for the last 5 years.  The Sensex at close of the last 4 financial years (2009-10 to 2012-13) are 17527, 19445, 17404 and 18835 respectively. Despite lot of action, news, optimism and pessimism, fear and greed; we are standing at the same place for the last 5 years. 

There is no need to despair. Reversion to the mean is always iron rule of the market. Despite earnings growth, markets have not moved up for last few years. Valuations need to catch up with earnings and also when the going gets good, would start discounting future earnings too. My belief is that we would reach the end of the tunnel in the next year or so as investment / Capex cycle and economic growth picks up. 

In tough times, we need to remember that our investment tenure for equity is not less than 10 years. In good times, results would give us faith. In tough times, only our faith would give good results. 

Our investment returns are based on earnings growth, where as market returns are Investment returns + or – Speculative returns. 

To illustrate, let us assume the earnings (EPS) of Sensex grow 15% in a year. So our investment returns are also 15%. Since market returns rarely matches investment returns year on year, the difference between investment returns and market returns are called speculative returns. 

In the example given above, the Sensex’s earnings grows at 15% in a given year; if the market returns, as measured by Sensex levels, is say 25%; then the speculative returns is 10% (25-15). In the same example, if the Sensex has gone down by 25%, then the speculative returns is -40% (-25-15). 

In the first case, for 15% growth, we got 25% returns. In the second case, for the same 15% growth, we got negative return of 40%. This would always be like this if we look on a year to year basis. 

But many studies have pointed out, if we take long periods for measurement, market returns are on par with investment returns. Speculative returns become almost zilch over the same period. Since over long term the market returns are same as the earnings growth or investment returns; there is no need for any concern. We’ve to ignore the negative speculative returns of last few years and stay the course. Negative speculative returns would always be offset by positive speculative returns and vice versa. 

At the cost of repetition, we’ve to focus only on the investment returns (earnings growth) and not the speculative returns. Speculative returns are positive for some years and negative for some years; but over long term, tend to be zero. So we can be rest assured that what we would receive over long term is actual investment returns.

(Note: Investment returns include dividend yield in addition to earnings growth. I’ve kept it simple to confuse you less:-)) 

In bull markets, I’ve seen advisors talking about 30% or 40% future annualized returns based on past performance. The same people now either don’t talk about equity returns or dare even to say a double digit returns. Both extremes are unnecessary and untrue. 

The market returns in the long run would be in tune with the growth of the economy. Assuming an 8% growth rate (we’ll be there) and 6% inflation, economy may grow at a nominal rate of 14% every year. So the investment and market returns can never be more than this number. But individual stocks or funds can give better returns based on how well the portfolio is structured. Good companies in a growing sector can give 1.25 to 1.5 times more than the economic growth, especially given the low base and growth potential of our economy. So my expectation is that 18% annualized returns for this decade is possible. 

We are entering the most or rather the only busy:-) time of the year. Its year end and I would share with each one of you, portfolio summary along with my reviews and analysis. Please note that for new clients who have been investing only for last 3 months; it is too early for a review and you would start receiving this from next year onwards. For all others, I’m working with an internal cut off date of May 10th. If you do not receive any communication from me till May 10th, request you to let me know. I would immediately share the relevant details.

Happy Easter & Happy long weekend.

3 Responses to “Sense of Sensex”

  1. amol said


    this article is important piece of information for reader like me.

    I have one question here

    Let us assume that for the years you mentioned here as 2009-10 to 2012-13 the sensex earnings grows at 15% annually. So the absolute returns at the end of 4 the year(2013) is 60%.
    but, sensex index value has just changed from 17527 to 18450(as on April 5, 2013) which is just 5.25% gain(tentatively) gain in the index value.

    so here, investment returns for TOTAL 4 year is 60% while market return is 5.25%(please correct me if I am wrong).

    How do I calculate the speculative return in this case ?
    Now since the good company’s earning have increased(by 15% growth annually) and market is still bearish on them that means the valuations are attractive.

    • Muthu said

      Dear Amol,

      In the example you gave, the speculative returns works out to (-) 54.75% (i.e.) 5.25-60

      In January 2008, the Sensex was quoting around 28 PE. Excess speculative positive returns are offset by subsequent excess negative speculative returns. Cycles happen to correct excesses on either side and as Bogle says, reversion to mean is the iron rule of stock markets.

  2. Mohan Raj said

    Dear Mr. Muthu,
    Looking forward to seeing many more articles of yours in future in press.

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